Tuesday, August 12, 2008

Recollections of Alt-A

There has been a lot of chat in the blogosphere about the real nature of Alt-A loans.Tanta has a brilliant post – and his recollection is at least as valid as mine – but different. He wants to focus on the bad bits of this market (and there were many) but for today I will focus on the good.

My take on this has a very big impact on Freddie Mac – so it is market topical.

Anyway – just as there are many takes on what constitutes subprime there are a few takes on what constitutes Alt-A and here is one.

Once upon a time (as long ago as the mid 1980s) there was a well run mutual thrift in Brooklyn called Greenpoint.It had a very nice – but somewhat risqué lending business.Greenpoint is no more. It was merged into North Fork Bancorp and then into Capital One Financial – so here I am talking about ancient history.

Essentially there are a lot of people in NYC who have done pretty well for themselves despite being illegal immigrants.They have all the characteristics of good borrowers – a family, a sizeable amount of equity, a desire to maintain the lifestyle the wife and kid have got used to, and a genuine ability and intent to pay the loan.They look like the super-prime borrowers of my modelling post – with delinquency well under 1 percent.

However they were illegals.And to get a “qualifying” mortgage from Fannie or Freddie you needed to give over a lot of documentation and these people were not that happy to do that.

Enter Greenpoint.Greenpoint lent on a limited or no documentation basis but a smell test and most importantly used its own valuers who were trained by the company and paid on salary not commission.Their lending was 35% down – but the deposit wasn’t the 35 percent (real though that was) it was the smell test conducted on the borrower.

This was a very good business – but hard to scale and hard to reproduce - it made good loans by properly training staff and by using all-in-house valuers.That didn’t stop others trying using outsourced brokers.It ended in tears the first time – when Citicorp lost 500 million and Dime Bancorp lost two thirds its capital.A lot has changed since then: Citicorp has become Citigroup and Dime Bancorp has become another spoke of Washington Mutual.The quality of Greenpoint was shown when they got through this crisis essentially unscathed…They had many defaults – but the loss given default averaged three percent.

Anyway this business was fundamentally limited because Greenpoint was a mutual which always had a limited deposit base.It demutualised, purchased some branches on Manhattan for the deposit base and moved itself to a more salubrious Manhattan address (the address where the CFO told me this story which I am repeating from memory).I believe (but could be persuaded otherwise) that the term Alt-A was coined by Greenpoint to explain what they were doing.And it really was an alterative to other A grade mortgages – to distinguish it from B&C business that was the then fashionable term for non-prime mortgages.

From here Greenpoint really hit the big time.Freddie Mac agreed to buy Greenpoint mortgages on a risk sharing basis.This meant that Greenpoint had access to the GSE/quasi-government guarantee spigot and was no longer limited by its deposit base. [I always wondered about the politics of using the GSE subsidy to support illegal immigrants given the xenophobia sometimes on exhibit in Washington but…]

This allowed Greenpoint to grow – which they did sensibly at first – keeping their culture of in-house valuers and their smell test. The growth rate became more rapid - and if I had to guess - I would think the standards fell as the growth rate rose. Standards are hard to maintain at a growing institution.

They merged with a mortgage company on the West Coast doing roughly the same thing – but getting some access to wholesale funding.That company was Headlands Mortgage founded and run by Peter Paul.Mr Paul became the largest shareholder in Greenpoint.

Anyway the scene in LA probably wasn’t that much different to NYC – with a bunch of illegals made good.The merger of Headlands with Greenpoint looked like a fit despite being on opposite sides of the country.(My direct knowledge here is limited.)

Greenpoint and Headland both grew with help from their friends at Freddie Mac.This was the bi-coastal non-standard mortgage lender – and as far as I can tell it kept moderately high standards for some time - although my ability to confirm that was low and I never purchased the stock.

I followed Greenpoint for another reason.Long time readers of this blog will know I was once short a lot of Conseco.Conseco had a truly dreadful business in manufactured housing lending.It eventually cost them the company and was the first place where widespread non-fraudulent defaults of AAA securitisation paper took place.The manufactured housing market in the period until 2002 is a pretty good indicator of how a non-prime mortgage crunch works.

Anyway thinking it could do one type of non-prime mortgage with better-than-average legwork it decided it could do another. It purchased Nations Bank’s manufactured housing lending business and became instantly the number 2 manufactured housing lender in the country.They called this business Greenpoint Credit.[For those without memory Nations Bank purchased the West Coast based Bank of America and changed its name – but kept its HQ in Charlotte.]This was an unmitigated disaster with Greenpoint eventually closing the business after losses that from memory were about a billion dollars.Peter Paul was called back to run Greenpoint Credit – and when it failed he eventually resigned his position on the board.Peter Paul retreated to charity and a mortgage company on the West Coast called Paul Financial.He services mortgages and as this entry at the Mortgage Implode site shows – he has not come out entirely unscathed.

As I was searching for links on this story I found a slightly different take on it here.They mention for instance a 75% loan to valuation threshold and a business helping tax evaders buy houses. The core part of the story – being the use of in-house trained valuers however does not change between my memory and this variant.

The point I make is that this was non-standard lending but was essentially sound because the collateral was essentially sound.But it also passed capacity and character tests as well.It really was an Alternative to A lending. Alt-A as a term used by Greenpoint was not misused.

Things changed

Just as Greenpoint was copied by people with lower standards in the lead-up to 1992 it was copied by people with lower standards again.The Alt-A business had made Greenpoint rich – but – given the manic competition – it became no longer possible to do the lending at the standard which Greenpoint expected.

The last I spoke with Greenpoint management (late 2003 I think but I have no notes) they were getting pretty down on the market - very early – pointing out then the insanity of some other lenders.[Note to readers: every bank during the boom will point to declining standards elsewhere but claim that they have maintained standards.Insurance companies do the same thing – and it is not collectively possible. The correct thing for management to do when all about them are losing their heads is either put themselves up for sale or stop writing business. Both of these are however career limiting.]

They did what a sensible management team will do when the game is up.They put themselves up for sale and North Fork purchased them at a good price.

North Fork tried unsuccessfully to get a good price for Greenpoint Mortgage.Nobody purchased even though this was once the best shop on the block. I didn't follow why - but my guess is that the business just wasn't that special any more becasue everyone had access to funds. What made Greenpoint special when it was good was (a) access to Freddie Mac, and (b) the in-house valuers. By 2004 none of this mattered.

North Fork eventually sold itself to Capital One – and I have lost all contact with or knowledge of the Greenpoint mortgage business.

I mention all this for two purposes.Firstly there has been a debate about what the Alt-A market really is.I agree with Tanta that at the end (and with the ridiculous levels of risk-layering) the loans made no sense.Indeed many were probably fraudulent.

But I am not sure that this sort of lender doesn’t come back.

The second reason I mention is that there is a lot of alarmism about the Alt-A book held by Freddie Mac.Mish for example is sure that Freddie is massively under-reserved for this.I suspect Mish is right – but if the book looks like the old Greenpoint book Mish will be wrong.

There were once good things in Freddie’s Alt-A book.The delinquency of that book says it is not all bad still – but it is certainly not the quality of Greenpoint in 1995.There was an extensive discussion of Alt-A in the last (disastrous) Freddie conference call – and whilst it is clear Freddie’s Alt-A is better than industry Alt-A, it is hardly pristine. The quality of Freddie's book declines massively by year of origination - leaving open the possibility that they were once snow-white - but they drifted. [This is an industry wide trend - but it is particularly pronounced at Freddie Mac.]

If anyone has a real feel for Freddie Mac’s Alt A business now could they share it.With a hundred billion in Alt-A and one billion in provisions this is the issue in analysing Freddie Mac.

But for the moment I just wanted an anti-dote to Tanta.

J

As a further link - this post on Blown Mortgage essentially argues that Alt-A was (or became) an excuse to do lending without underwriting.

I think that is right - but it is not necessarily the case. In the days when Greenpoint had limited access to funds it lent those funds very well. As access to funding increased the quality of the lending for the whole industry deteriorated. In the end it was comically low.

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